Weekly Forex Currency Review 20-03-2008

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Overall strategy: Conditions within the US economy and global financial markets will continue to drive currency markets in the short-term. The yen and Swiss franc will continue to gain defensive support on financial fears, but the Fed efforts to boost liquidity should start to stabilise risk conditions which will ease the sense of panic and curb defensive demand. Sterling has now discounted a substantial amount of bad UK economic news.  

Key events for the forthcoming week 

Dollar:

There will be further fears over a protracted US downturn with strong speculation that the economy is already in recession. The aggressive Federal Reserve interest rate policy will also reinforce the dollar's lack of yield support. The Fed policy and regulatory action will, however, also provide some important reassurance that the authorities will be able to tackle the credit and liquidity-related difficulties which should help underpin confidence. Underlying dollar sentiment will remain weak with fears over reserve diversification. Nevertheless, there is scope for a further corrective recovery, especially given the continuing possibility of central bank intervention.
      
The dollar was subjected to further intense selling pressure at the beginning of the week with fresh record lows against the Euro and a sharp decline on a trade-weighted index. The US currency was then able to secure a tentative recovery as conditions calmed. A sharp drop in commodity prices provided additional dollar support with gains to beyond 1.55 against the Euro.

Following the effective collapse of Bear Stearns at the end of last week, the bank was bought for US$250mn by JP Morgan. Over the weekend, the Fed announced further measures to boost liquidity within the money markets. The central bank also announced an interim 0.25% cut in the discount rate.

At the FOMC meeting, the Federal Reserve announced a further 0.75% cut in the Fed Funds rate to 2.25% with the discount rate also reduced by 0.75%. The Fed stated that downside risks to the economy continued while there was also greater uncertainty over the inflation outlook.

There was a further relaxation of regulation for mortgage finance companies Freddie Mac and Fannie Mae. This will enable them to take on more distressed mortgages and release around US$200bn in liquidity into the mortgage sector.

The quarterly results from key investment banks such as Goldman Sachs and Lehman Brothers were stronger than expected and this provided some relief even though profits still fell sharply over the year.

The US current account fell to US$173bn for the fourth quarter from US$177bn previously as investment income remained firm and the deficit was just below 5.0% of GDP. Long-term capital inflows were little changed at US$62bn for January.

Housing starts were little changed for February at 1.07mn after an upward revision to the January data, but permits were at a 16-year low. The New York manufacturing survey fell to a record low of -22.2 for March.

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The firm ECB stance on inflation and monetary policy will provide further near-term Euro support, especially given the sharp drop in US short-term yields. Euro-zone growth trends will remain very important as the Euro will be very vulnerable if there is evidence of a rapid deterioration in conditions. There will be fears that the ECB has delayed a monetary response for too long which would trigger a sharp downturn. There will also be persistent fears over divergent economic trends which would create substantial medium-term Euro stresses.      
       
After initial strength, the Euro weakened over the second half of the week as the dollar recovered while there were losses against the Japanese yen and Swiss franc.

The was little in the way of Euro-zone growth-related data, although the PMI indices edged lower for March which suggested an underlying slowdown in the economy. The Euro-zone trade account also weakened to a seasonally-adjusted EUR2.0bn deficit for January which suggested that export growth was faltering.

ECB members generally took a firm stance on inflation over the week with officials concentration in particular on the need to avoid secondary inflation pressures. ECB sources stated that the bank was concerned over the level of the Euro against the dollar, but that this did not necessarily mean that there would be market intervention.

Yen:  

The Japanese economy is continuing to show signs of a slowdown which will undermine yen sentiment. Degrees of risk aversion will, however, tend to remain dominant as investors monitor global risk. The yen will continue to gain support when market fears intensify, especially given the potential for capital repatriation. Domestic investors have also been selling the dollar aggressively, but there will be the threat of central bank intervention to stabilise conditions. Any easing of risk aversion would also trigger renewed yen selling pressure.
                    
The Japanese currency strengthened very sharply at the end of last week and the gains extended to fresh 12-year high against the US dollar on Monday. The US currency corrected stronger, but struggled to sustain moves back above the 100 level.

There was further friction over the appointment of a new Bank of Japan governor. The Upper House of parliament continued to veto government nominations and one of the Deputy governors had to take temporary control as Fukui left office.

The yen moves continued to be influenced strongly by degrees of risk aversion with the yen gaining strongly as fears over the US and global financial sector escalated. Volatility was a key factor with the dollar suffering the biggest daily decline for eight years before rallying by the largest amount for four years.

There were protests against excessive currency moves by Finance Ministry officials, but there was no evidence of actual intervention.

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There will be persistent fears over the housing sector and the outlook for consumer spending, especially as credit tightening is liable to continue.  There will also be further unease over the UK banking sector which will increase pressure for an early cut in interest rates. Sterling has, however, fallen very sharply over the past few months which will boost competitiveness. The retail data was also firm which will increase the potential for a significant correction, especially if the banking fears ease temporarily.        
 
Sterling weakened sharply both on Friday and Monday following the Bear Stearns collapse. After a corrective recovery, the UK currency was subjected to further selling pressure. There was a fresh retreat to near 0.79 against the Euro before a recovery after the retail data. The UK currency dipped to lows below 1.98 against the dollar.

The UK currency was damaged by fears surrounding the international financial sector and was also undermined by specific rumours surrounding the UK banking sector.

The headline UK consumer inflation report recorded an increase in the headline rate to 2.5% from 2.2% the previous month as energy and food prices rose strongly, but the core rate fell to 1.2% from 1.3% the previous month.

There was a further reported decline in unemployment for February, but the rate of decline slowed sharply. The latest CBI industrial survey recorded an increase in orders for March while export orders were reported at the highest level for over 12 years. Retail sales rose 1.0% in February after a revised 1.1% increase the previous month even though sales of household goods were weak

The minutes from March's Bank of England meeting reported a 7-2 vote for unchanged policy with Blanchflower and Gieve voting for an immediate cut in rates.
 
Swiss franc:

The economy is liable to weaken, but unless there is evidence of serious stress within the domestic banking sector, international considerations will tend to dominate in the short-term. The Swiss franc will continue to gain support from elevated levels of risk aversion and fears over the global economic conditions. The Fed efforts to underpin liquidity should lessen franc demand to some extent and any easing of tensions would reduce near-term franc demand. The currency is unlikely to strengthen much further unless there is another key bank failure.   
 
The franc pushed through the parity level against the US dollar late last week and strengthened further to highs near 0.96 before a retreat back to 1.01 on Thursday as the dollar rallied. The franc secured net gains against most major currencies.

The Swiss currency gained strong support from elevated levels of risk aversion with a particular focus on financial-sector risk which boosted defensive franc demand.

National Bank member Hildebrand stated that he was concerned over the franc's appreciation, although it was too early to say whether the gains would be sustained.

There was a sold increase for industrial production for the fourth quarter while the rate of retail sales growth weakened.

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The Australian dollar peaked at levels around 0.9450 against the US currency. Thereafter, there was a weaker tone with lows below 0.9100 as elevated risk aversion combined with a very sharp drop in commodity prices.

Moves were influenced strongly by degrees of risk aversion with the currency weakening sharply as global markets were subjected to heavy selling pressure. The Australian dollar was also hampered by a very sharp decline in gold prices on Wednesday and Thursday following the recent strong gains.

The minutes from March's Reserve Bank of Australia interest rate meeting suggested that there would be greater reluctance to tighten interest rates further, especially with signs of a slowdown in domestic demand.

The Australian dollar will gain if risk aversion eases, but the net risks suggest that progress will be limited, especially with a slowdown in the domestic economy.

Canadian dollar:

The Canadian dollar was unable to strengthen through the 0.98 level against the US currency and weakened sharply to lows beyond 1.0250 during Thursday.

The currency drew initial support from improved yield differentials following the latest US Federal Reserve interest rate cut.

The Canadian dollar was influenced strongly by levels of risk aversion with the currency weakening when there were serious financial-market stresses. The currency was also influenced by commodity prices with sharp losses as oil and gold prices corrected lower during the second half of the week.

The annual core inflation rate increased to 1.5% in February from 1.4% the previous month, although there were still strong expectations that the Bank of Canada would cut interest rates further over the next few months.

Economic vulnerabilities will tend to weaken the Canadian dollar with expectations of lower interest rates, although near-term yield support should curb heavy selling pressure unless oil prices continue to slide rapidly.

Indian rupee:

The rupee dipped to fresh six-month lows against the US currency during the week with a low near 40.80. The rupee was undermined by the escalation in risk aversion with the stock market falling sharply early in the week due to global financial fears. The rupee was again unsettled by the high level of oil prices early in the week.

There was some respite in markets later in the week and this allowed the rupee to recover back towards 40.45. Yield support remain an important positive influence, especially as the central bank voiced opposition to lower domestic interest rates.

Elevated levels of risk aversion will remain the principal short-term rupee threat, but heavy selling from current levels should be resisted with a tentative recovery.

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The Hong Kong dollar gained ground over the week and probed levels beyond 7.77 which was the strongest level for 2008. The HKMA matched the US Fed Funds rate cut with a cut of 0.75% to 3.75%. A US dollar recovery pushed the local currency back to 7.7770 on Thursday as local overnight interest rates dipped to below 1.0%.

There was speculation that the Hong Kong authorities would abandon the currency peg. The speculation was driven by renewed losses for the US currency while there were increased fears over inflation, especially with lower interest rates. Expectations of a stronger Chinese yuan also fuelled the speculation of a Hong Kong policy shift.

The Hong Kong currency should remain firm in the short-term and there will be increased speculation over  a revaluation or a abandonment of the currency peg.

Chinese yuan:

The Chinese yuan continued to gain ground over the week with the Central bank setting a fresh post-revaluation high around 7.05 on Thursday. There were further gains at the end of the week even though the US currency had recovered.

The central bank announced a further increase in reserve requirements to 15.5% during the week which is the highest level on record.

There was further speculation that the Chinese authorities would also sanction a one-off yuan revaluation to help curb inflation pressures within the economy.

The yuan will remain strong in the short-term with further gains realistic, although there is a strong probability that gains will slow and possibly reverse over the second half of 2008.

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New York, February 26, 2008  dbFX, the leading retail online  currency trading platform from Deutsche Bank, experienced the highest  volumes of trading during January 2008 since its launch in June 2006.

Nearly half of all retail trades executed during January over dbFX  were Euro / USD transactions, compared to an average of 15% in the three months prior to the market turmoil that began in August 2007. The surge in Euro / USD trading peaked on January 16th when 70% of  daily trading was between this currency pair.

Immediately after the FED's first interest rate cut of 75 base points on January 22nd , the U.S. dollar lost ground against the Euro as the Euro / USD currency pair accounted for 40% of trading on the following day, and nearly 50% on January 24th. As a result of the FED's cut, the next day's trading of the Japanese  yen was down against the world's other major currencies, most notably against the Euro where volumes were slashed by half to just 8% of daily trading volumes.

Trading of the Japanese yen against the U.S. dollar continued to decline and accounted for less than 10% of  January's total volume on dbFX, down nearly half against the previous  month's figures. dbFX has 34 currency pairs available to investors on  its platform.

Commenting on January's volumes, Betsy Waters, Director and head of dbFX Americas said, "Tumbling equity prices prompted investors to look  for asset classes where they could make money, and FX presented such  an opportunity. In January, we saw a 'flight to quality' in currency  trading."

Launched in 2006, dbFX is available in multiple languages and accessible in over 70 countries around the world. Deutsche Bank was  ranked the No.1 Foreign Exchange Bank in 2007 by Euromoney magazine  for the third year running. The platform can be accessed here